Costco: Growing Giant

This club warehouse chain continues to grow, and its shares aren't overpriced, says one fund manager.

January 23, 2006

Don't just think of Costco as a good place to shop. Think of its stock (symbol COST) as a good buy, says Ken Feinberg, co-manager of Selected American Shares and Davis New York Venture funds.

With 471 stores and $58 billion in sales last year, Costco is the nation's largest club warehouse chain. It generates annual revenues of $120 million per warehouse, compared with just $58 million in sales at each Sam's Club store. Higher sales per store mean that Costco benefits more from economies of scale.

Costco continues to grow. The number of stores will double over the next ten years, Feinberg says, and sales are rising 10% annually. The company has "fanatical management focused on value for the customer and managing for the long term," Feinberg says. Indeed, he thinks Costco can raise prices when it wants to. The company's operating profit margin is less than 3%. "They can raise that quite a bit," Feinberg says.

At $49, the stock sells at 21 times the $2.38 per share that analysts expect Costco to earn in the 12 months ending this November. That's above the market's price-earnings ratio. But, Feinberg insists, Costco's shares aren't overpriced, given the company's growth potential and its strong balance sheet: Costco has virtually no debt and holds more than $3 billion in cash.

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There are risks, of course. Costco has thrived because it offers better merchandise and service than Sam's Club. But Wal-Mart (WMT), which owns Sam's Club, has awakened to that fact and is now trying to catch Costco. Another risk: Costco's generous and steadily rising compensation costs, particularly for health care.